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NeoStem Announces Several Key Milestones That Should Excite Investors
Jul 22 2013, 13:52 by: Equity Options Guru | about: NBS 23:22Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

It can be a difficult process to try and identify the best stocks in the biotechnology world. Each biotech claims to have perfected its relevant science and investors need to look past that and actually decide which ones are contenders and which ones are pretenders. One stock that appears to be on the path to glory is NeoStem (NBS). After a busy week of announcements, it's important for investors to understand each one and their potential impact on the company. But before we analyze them, let's give investors a quick overview of why so many are excited about the future prospects of NeoStem.

Company Background

NeoStem is a one of the top companies in the cellular therapy industry. Cellular therapy is the process of introducing new cells into a tissue in order to treat a disease. Cell therapies often focus on the treatment of hereditary diseases, with or without the addition of gene therapy. There are many forms of cell therapy which include the following:

The transplantation of stem cells or progenitor cells that are from the patient or from another donor
The transplantation of mature, functional cells
The application of modified human cells that are used to produce a needed substance
In addition to developing novel proprietary cell therapies, NeoStem also operates a contract development and manufacturing organization that provides services for the regenerative medical industry.

The Science

In terms of a niche within the biotech space, NeoStem would certainly fall into the category known as stem cells. Today, stem cells are defined by having the following two key characteristics:

Self-renewal: Stem cells are capable of dividing and renewing themselves over long periods of time
Differentiation: Stem cells are unspecialized. When stem cells divide, each new cell has the potential to either remain a stem cell or to differentiate into a specialized cell
There are three types of stem cells which are embryonic stem cells, tissue-derived stem cells, and induced pluripotent stem cells.

Embryonic stem cells: These particular cells give rise to all the different types of cells found throughout the organism as it grows and matures. Characterized as being pluripotent, these cells have the advantage that they can make any cell type.
Tissue-derived stem cells: These cells are also known as adult stem cells or somatic stem cells, also termed multipotent stem cells. They can produce all the functional cell types found within the tissue from which they are derived.
Induced pluripotent stem cells: These are differentiated cells that have been genetically reprogrammed to a pluripotent state resembling embryonic stem cells. It is not yet known if these cells will behave differently from embryonic or tissue-derived stem cells when used as therapeutics.
In addition to stem cells, there are also progenitor cells. These particular cells are more specialized than stem cells. They are early descendants of stem cells and, like stem cells; they can differentiate into more specialized cells comprising a specific organ.

The Hope For Stem Cell Therapy

The science community strongly believes that stem cell therapy has the capability to improve the treatment of human disease. Many therapies involving stem cells already exist, such as bone marrow transplants that are used to treat leukemia. Once the science has been further developed, doctors hope to utilize technology platforms built from stem cell research to treat a wide array of terminal diseases such as various forms of cancer, spinal cord injuries, multiple sclerosis, and Parkinson's disease. NeoStem hopes to be the leader once the science takes off.

Reverse Split

NeoStem announced that it would be undergoing a reverse split that would be effective for trading on July 16, 2013. The split itself has no impact on the valuation of the company. During a reverse split, a company's outstanding shares are reduced according to the ratio specified in the official announcement. At the same time, the share price is adjusted up at the same ratio to keep the company's market capitalization equivalent. In NeoStem's case, their outstanding shares were adjusted from 196,643,748 to approximately 19.7 million. With the stock now trading around 6.65 per share, the company's market capitalization remains roughly at $135 million.

There are many examples of reverse splits benefiting stocks. The most successful reverse split that comes to mind is American International Group (AIG). AIG shares closed at $1.16 on June 30, 2009. After the close, the post-split price became $23.20 (after a 1-20 reverse split). Since then, the stock has done nothing but soar causing all shareholders to stand up and applaud the decision to leave the single digit trading range. AIG currently trades at $46.97 meaning that its share price has more than doubled since the reverse split. Likewise with NeoStem, I anticipate shareholders being very pleased with this decision a few years down the road. Now that NeoStem no longer trades in pennies, institutional investors are much more likely to consider investing here which will allow for price stability going forward.

Diabetes Announcement

On July 15, 2013, NeoStem announced that it had finalized agreements with the University of California, San Francisco and the laboratories of Jeffrey Bluestone and Qizhi Tang, to collaborate on the development of human Regulatory T cells for the treatment of type 1 diabetes, steroid resistant asthma, and organ transplant rejection. With NeoStem already having a deep pipeline of studies in these areas, this only strengthens the company's potential for future revenue monetization. Across the world, there are more than 340 million people that are afflicted with type 1 diabetes. Given the size of this market and the need for better and more efficient treatment options, this announcement represents a huge opportunity for NeoStem and potentially a lucrative opportunity for investors.

Analyst Coverage and Valuation Target

Last month, Aegis Capital initiated a research report describing the potential valuation of NeoStem. In their report, they ascribed a value of $200 million to the Progenitor Cell Therapy division. No matter the impact, given that NeoStem's market cap as a whole barely sits over $124 million, investors should realize the potential here.

Fundamentals

Clearly NeoStem has had a very busy past week. With all of these announcements, it can be a challenge for investors to stay in the loop. However, one thing that investors can certainly appreciate is the strong financial position of NeoStem.

In the land of small biotechnology companies, rapidly declining cash balances and stagnant or non-existent revenue streams seem to be the norm. That is far from the case with NeoStem. The most important area on the financial statements that investors need to pay attention to is the cash balance. At the end of the first quarter 2013, NeoStem had a cash position of $9.25 million. However, the company also sold 23 million shares of stock for $0.50 per share in early May for which it received $11.5 million. Add this to the cash position of at the end of the first quarter and NeoStem actually has more than $20 million of available cash to fund future trials and continue developing their technology. With a cash burn rate between $2 and $3 million per month, the company should have enough cash to last at least the rest of the year without having to issue additional shares. Investors should also expect the cash burn rate to lessen towards the end of the year. It is currently at the peak because of the fact that PreSERVE Phase II trial is at its peak enrollment.

A few other important line items on the company's balance sheet include the long-term debt and other liabilities. For the long-term debt, the company was able to reduce the amount by $33,000 from the end of 2012. Total liabilities actually decreased by almost $700,000 from $21.59 million to $20.89 million.

The balance sheet certainly has its positives and negatives. The positive would be the existing cash position but given that the liabilities are about $21 million and the cash burn rate per month is between $2 and $3 million, investors should understand that further secondary offerings are probable. Earlier this year, the company raised approximately $11 million in a secondary. A similar event is probable for either late this year or early next year.

The hope for investors is that the company's current revenue producer, Progenitor Cell Therapy, can continue to demonstrate the revenue growth it has shown thus far. This could help reduce the need for additional cash through secondary offerings in the future. Investors will notice a record high of $14.33 million in revenue generation during the prior year. This is an increase of more than $4 million compared to 2011. Additionally, during the most recent quarter, NeoStem had one of its best quarters which, resulted in a net income loss of $8.8 million. For a company building out an expensive technology platform and funding enrollment for trials, the company appears to be doing about as good of a job as one could expect. With that being said, there are financial risks here and investors need to be cautious before investing.

Risks

As a development stage stem cell company, the risks are significant. Investors need to be aware of all that could go wrong and potential financing issues. For me, the big issue is potential dilution in the future. Earlier this year, NeoStem raised approximately $11 million in a secondary. Given the liabilities that the company has along with its cash burn rate of between $2 and $3 million per month, I would anticipate another similar secondary offering either later this year or early next year. A second risk is bad data from the PreSERVE Phase II trial. NeoStem expects to have this data available in the early part of 2014. Although I expect positive data, Phase II trials can be risky. The thing that gives me confidence is that Aegis Capital recently assigned a value of $250 million risk-adjusted Net Present Value to this trial. Given this and the fact that NeoStem's entire valuation sits just above $120 million, the return seems to outweigh the risk at these price levels. A third and final risk is from competition within the industry. Stem cells are one of the hottest spaces within the biotechnology industry. With so much competition, timing appears to be one of the most important factors facing all companies. Investors are left wondering who will get to the finish line first. However, should NeoStem have a successful Phase II trial in the early part of 2014, they will be well on their way to being one of the first.

Conclusion

The biotechnology industry is one of my favorite spots to look for undervalued, small cap companies looking for the next big medical breakthrough. And while this space carries risk, the potential returns make an investment here worth it. Given all the upcoming catalysts that NeoStem has, and the recent valuation of $25.00 (adjusted post-split) per share ascribed by Aegis Capital, investors should strongly consider adding this company to their portfolio.




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